MERCHANT BANKING V/S. COMMERCIAL BANKING: AN OVERVIEW

STUDENT NAMEROLL NOSPECIALIZATION: FINANCE

WELINGKAR INSTITUTE OF MANAGEMENT DEVELOPMENT AND RESEARCH.

YEAR OF SUBMISSION: JANUARY 2014

ACKNOWLEDGEMENT

With immense pleasure I would like to present this report on MERCHANT BANKING VS. COMMERCIAL BANKING AN OVERVIEW

I would like to thank Welingkar Institute of Management for providing me opportunity to present this report.

My special thanks to ___________ (Project Guide) for her invaluable guidance, cooperation and for taking time out her busy schedule to help me.

Acknowledgements are due to my parents, friend and all those who help me directly or indirect in the successful completion of project.

STUDENT NAME ROLL NO

CERTIFICATE FROM THE GUIDE

This is to certify that the Project work titled INSRUMENTS OF FOREIGN TRADE AN OVERVIEW is a confide work carried out by _________ (Roll No. ______ ) a candidate for Post Graduate Diploma Examination of the Welingkar Institution of Management under my guidance and direction.

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DATE : 10/04/2013PLACE : Mumbai

TABLE OF CONTENTSSR NOPARTICULARSPAGE NO

1. Introduction5

2.History of Merchant & Commercial Bank7

3.Types of Merchant Bank8

4.Functions of Commercial Bank9

5.Need & Importance 18

6.Objectives of Commercial & Merchant Bank 22

7.Obligations & Responsibilities of Merchant & Commercial Banks24

8.Leading Merchant & Commercial Banks in India63

9.Difference between Merchant & commercial Banks67

10.Conclusions72

11.Bibliography & Webliography75

INTRODUCTIONMERCHANT BANKINGMEANING:

Merchant banking is concerned with mobilizing savings of people and directing the funds to business enterprise.A Merchant Bank can be generally described as a financial services company with a private equity investment arm offering investment banking and ancillary services as well. Because a merchant bank acts not only as an advisor and broker but also as a principal, a merchant bank has a longer term approach than a typical investment bank and is highly concerned with the viability of each investment opportunity and providing the right advice for a strong partnership with each client company.

In banking, a merchant bank is a traditional term for an Investment Bank. It can also be used to describe the private equity activities of banking. This article is about the history of banking as developed by merchants, from the Middle Ages onwards.

Amidst the swift changes sweeping the financial world, Merchant Banking has emerged as an indispensable financial advisory package. Merchant banking is a service-oriented function that transfers capital from those who own to those who can use it. They try to identify the needs of the investors & corporate sector & advice entrepreneurs what to do to be successful. The merchant banking has been defined as to what a merchant banker does.

DEFINITION:

A Merchant Bank is a British term for a bank providing various financial services such as accepting bills arising out of trade, providing advice on acquisitions, mergers, foreign exchange, underwriting new issues, and portfolio management.

A merchant Banker has been defined by Securities Exchange Board Of India (Merchant Banker) rules, 1992, as Any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities or acting as manager, consultant, advisor or rendering corporate advisory services in relation to such issue management.

A British term for a bank that specializes not in lending out its own funds, but in providing various financial services such as accepting bills arising out of trade, underwriting new issues, and providing advice on acquisitions, mergers, foreign exchange, portfolio management, etc.

An investment bank that commits its own funds by taking a creditor position or equity interest in another firm.

An activity that includes corporate finance activities, such as advice on complex financings, merger and acquisition advice (international or domestic), and at times direct equity investments in corporations by the banks.

COMMERCIAL BANK

MEANING:A commercial bank is a type of bank that provides services such as accepting deposits, making business loans, and offering basic investment products.Commercial bank can also refer to a bank or a division of a bank that mostly deals with deposits and loans from corporations or large businesses, as opposed to individual members of the public (retail banking).In the US the term commercial bank was often used to distinguish it from an investment bank due to differences in bank regulation. After the great depression, through the GlassSteagall Act, the U.S. Congress required that commercial banks only engage in banking activities, whereas investment banks were limited to capital markets activities. This separation was mostly repealed in the 1990s.

DEFINITION:A financial institution that provides services, such as accepting deposits, giving business loans and auto loans, mortgage lending, and basic investment products like savings accounts and certificates of deposit. The traditional commercial bank is a brick and mortar institution with tellers, safe deposit boxes, vaults and ATMs. However, some commercial banks do not have any physical branches and require consumers to complete all transactions by phone or Internet. In exchange, they generally pay higher interest rates on investments and deposits, and charge lower fees.

HISTORY OF MERCHANT BANK

In late 17th and early 18th century Europe, the largest companies of the world was merchant adventurers. Supported by wealthy groups of people and a network of overseas trading posts, the collected large amounts of money to finance trade across parts of the world. For example, The East India Trading Company secured a Royal Warrant from England, providing the firm with official rights to lucrative trading activities in India. This company was the forerunner in developing the crown jewel of the English Empire. The English colony was started by what we would today call merchant bankers, because of the firm's involvement in financing, negotiating, and implementing trade transactions. The colonies of other European countries were started in the same manner. For example, the Dutch merchant adventurers were active in what are now Indonesia; the French and Portuguese acted similarly in their respective colonies. The American colonies also represent the product of merchant banking, as evidenced by the activities of the famous Hudson Bay Company. One does not typically look at these countries' economic development as having been fueled by merchant bank adventurers. However, the colonies and their progress stem from the business of merchant banks, according to today's accepted sense of the word. Merchant banks, now so called, are in fact the original "banks". These were invented in the middle Ages by Italian grain merchants. As the Lombardy merchants and bankers grew in stature on the back of the Lombard plains cereal crops many of the displaced Jews who had fled persecution after 613 entered the trade. They brought with them to the grain trade ancient practices that had grown to normalcy in the middle and Far East, along the Silk Road, for the finance of long distance goods trades.

The Jews could not hold land in Italy, so they entered the great trading piazzas and halls of Lombardy, alongside the local traders, and set up their benches to trade in crops. They had one great advantage over the locals. Christians were strictly forbidden the sin of usury. The Jewish newcomers, on the other hand, could lend to farmers against crops in the field, a high-risk loan at what would have been considered usurious rates by the Church, but did not bind the Jews. In this way they could secure the grain sale rights against the eventual harvest. They then began to advance against the delivery of grain shipped to distant ports. In both cases they made their profit from the present discount against the future price. This two-handed trade was time consuming and soon there arose a class of merchants, who were trading grain debt instead of grain.

HISTORY OF COMMERCIAL BANK

The Commercial Bank of India, also known as Exchange Bank was a bank which was established in Bombay Presidency (now Mumbai), in 1845 of the British Raj period. The bank failed in the crash of 1866, after successfully operating for 20 years. The bank had eight branches, exclusive of the head office at Bombay, viz: London, Calcutta, Hong Kong, Foochow, Shangai, Hankow, Yokohama and Singapore, with an agency for the purchase of bullion at San Francisco. Commercial Bank of India then was winded up as directed by the Master of the Rolls, under the corresponding section of the Companies Act of England, where the company was registered under the Indian law and was not registered in England, but was carrying on business in EnglandTYPES OF MERCHANT BANKING

Traditional Merchant Banking

Merchant Banking, as the term has evolved in Europe from the 18th century to today, pertained to an individual or a banking house whose primary function was to facilitate the business process between a product and the financial requirements for its development. Merchant banking services span from the earliest negotiations from a transaction to its actual consummation between buyer and seller.

The merchant banker acted as a capital sources whose primary activity was directed towards a commodity trader/cargo owner who was involved in the buying, selling, and shipping of goods. The role of the merchant banker, who had the expertise to understand a particular transaction, was to arrange the necessary capital and ensure that the transaction would ultimately produce "collectable" profits.

Modern Merchant Banking

During the 20th century, however, European merchant banks expanded their services. They became increasingly involved in the actual running of the business for which the transaction was conducted. Today, merchant banks actually own and run businesses for their own account, and that of others.Since the 18th century, the term merchant banker has, therefore, been considerably broadened to include a composite of modern day skills. These skills include those inherent in an entrepreneur, a management advisor, a commercial and/or investment banker plus that of a transaction broker. Today a merchant banker is who has the ability to merchandise -- that is, creates or expands a need -- and fulfill capital requirements. The modern European merchant bank, in many ways, reflects the early activities and breadth of services of the colonial trading companies. Most companies that come to a U.S. merchant bank are looking to increase their financial stability or satisfy a particular, immediate capital need.

Functions of Merchant Bankers:

Consulting advice on going public and international business. Advice and help in taking your company public. If they are unwilling to supply Investment Banking bridge loans, they have a low cost strategy for taking your company public. They do PIPE (Private Investment in Public Equities) financings. They can advise or help with a companys M&A strategy. They are essential advisors for companies seeking to become multinational corporations.

FUNCTIONS OF COMMERCIAL BANKSThe commercial banks serve as the king pin of the financial system of the country. They render many valuable services. The important functions of the Commercial banks can be explained with the help of the following chart.

PRIMARY FUNCTIONSThe primary functions of the commercial banks include the following:A. Acceptance of Deposits1. Time Deposits:These are deposits repayable after a certain fixed period. These deposits are not withdrawn able by cheque, draft or by other means. It includes the following.(a) Fixed Deposits:The deposits can be withdrawn only after expiry of certain period say 3 years, 5 years or 10 years. The banker allows a higher rate of interest depending upon the amount and period of time. Previously the rates of interest payable on fixed deposits were determined by Reserve Bank.Presently banks are permitted to offer interest as determined by each bank. However, banks are not permitted to offer different interest rates to different customers for deposits of same maturity period, except in the case of deposits of Rs. 15 lakhs and above.These days the banks accept deposits even for 15 days or one month etc. In times of urgent need for money, the bank allows premature closure of fixed deposits by paying interest at reduced rate. Depositors can also avail of loans against Fixed Deposits. The Fixed Deposit Receipt cannot be transferred to other persons.

(b) Recurring Deposits:In recurring deposit, the customer opens an account and deposit a certain sum of money every month. After a certain period, say 1 year or 3 years or 5 years, the accumulated amount along with interest is paid to the customer. It is very helpful to the middle and poor sections of the people. The interest paid on such deposits is generally on cumulative basis. This deposit system is a useful mechanism for regular savers of money.(c) Cash Certificates:Cash certificates are issued to the public for a longer period of time. It attracts the people because its maturity value is in multiples of the sum invested. It is an attractive and high yielding investment for those who can keep the funds for a long time.It is a very useful account for meeting future financial requirements at the occasion of marriage, education of children etc. Cash certificates are generally issued at discount to face value. It means a cash certificate of Rs. 1, 00,000 payable after 10 years can be purchased now, say for Rs. 20,000.2. Demand Deposits:These are the deposits which may be withdrawn by the depositor at any time without previous notice. It is withdraw able by cheque/draft. It includes the following:(a) Savings Deposits:The savings deposit promotes thrift among people. The savings deposits can only be held by individuals and non-profit institutions. The rate of interest paid on savings deposits is lower than that of time deposits. The savings account holder gets the advantage of liquidity (as in current a/c) and small income in the form of interests.But there are some restrictions on withdrawals. Corporate bodies and business firms are not allowed to open SB Accounts. Presently interest on SB Accounts is determined by RBI. It is 4.5 per cent per annum. Co-operative banks are allowed to pay an extra 0.5 per cent on its savings bank deposits.(b) Current Account Deposits:These accounts are maintained by the people who need to have a liquid balance. Current account offers high liquidity. No interest is paid on current deposits and there are no restrictions on withdrawals from the current account.These accounts are generally in the case of business firms, institutions and co-operative bodies. Nowadays, banks are designing and offering various investment schemes for deposit of money. These schemes vary from bank to bank.It may be stated that the banks are currently working out with different innovative schemes for deposits. Such deposit accounts offer better interest rate and at the same time withdraw able facility also. These schemes are mostly offered by foreign banks. In USA, Current Accounts are known as 'Checking Accounts' as a cheque is equivalent to check in America.

B. Advancing of LoansThe commercial banks provide loans and advances in various forms. They are given below:1. Overdraft:This facility is given to holders of current accounts only. This is an arrangement with the bankers thereby the customer is allowed to draw money over and above the balance in his/her account. This facility of overdrawing his account is generally pre-arranged with the bank up to a certain limit.It is a short-term temporary fund facility from bank and the bank will charge interest over the amount overdrawn. This facility is generally available to business firms and companies.2. Cash Credit:Cash credit is a form of working capital credit given to the business firms. Under this arrangement, the customer opens an account and the sanctioned amount is credited with that account. The customer can operate that account within the sanctioned limit as and when required.It is made against security of goods, personal security etc. On the basis of operation, the period of credit facility may be extended further. One advantage under this method is that bank charges interest only on the amount utilized and not on total amount sanctioned or credited to the account.Reserve Bank discourages this type of facility to business firms as it imposes an uncertainty on money supply. Hence this method of lending is slowly phased out from banks and replaced by loan accounts. Cash credit system is not in use in developed countries.3. Discounting of Bills:Discounting of Bills may be another form of bank credit. The bank may purchase inland and foreign bills before these are due for payment by the drawer debtors, at discounted values, i.e., values a little lower than the face values.The Banker's discount is generally the interest on the full amount for the unexpired period of the bill. The banks reserve the right of debiting the accounts of the customers in case the bills are ultimately not paid, i.e., dishonoured.The bill passes to the Banker after endorsement. Discounting of bills by banks provide immediate finance to sellers of goods. This helps them to carry on their business. Banks can discount only genuine commercial bills i.e., those drawn against sale of goods on Credit. Banks will not discount Accommodation Bills.4. Loans and Advances:It includes both demand and term loans, direct loans and advances given to all type of customers mainly to businessmen and investors against personal security or goods of movable or immovable in nature. The loan amount is paid in cash or by credit to customer account which the customer can draw at any time.The interest is charged for the full amount whether he withdraws the money from his account or not. Short-term loans are granted to meet the working capital requirements where as long-term loans are granted to meet capital expenditure.Previously interest on loan was also regulated by RBI. Currently, banks can determine the rate themselves. Each bank is, however required to fix a minimum rate known as Prime Lending Rate (PLR).Classification of Loans and AdvancesLoans and advances given by bankers can be classified broadly into the following categories:(i) Advances which are given on the personal security of the debtor, and for which no tangible or collateral security is taken; this type of advance is given either when the amount of the advance is very small, or when the borrower is known to the Banker and the Banker has complete confidence in him (Clean Advance).(ii) Advances which are covered by tangible or collateral security. In this section of the study we are concerned with this type of advance and with different types of securities which a Banker may accept for such advances (Secured Advance).(iii) Advances which are given against the personal security of the debtor but for which the Banker also holds in addition the guarantee of one or more sureties. This type of advance is often given by Banker to persons who are not known to them but whose surety is known to the Banker. Bankers also often take the personal guarantee of the Directors of a company to whom they agree to advance a clean or unsecured loan.(iv) Loans are also given against the security of Fixed Deposit receipts.5. Housing Finance:Nowadays the commercial banks are competing among themselves in providing housing finance facilities to their customers. It is mainly to increase the housing facilities in the country. State Bank of India, Indian Bank, Canara Bank, Punjab National Bank, has formed housing subsidiaries to provide housing finance.The other banks are also providing housing finances to the public. Government of India also encourages banks to provide adequate housing finance.Borrowers of housing finance get tax exemption benefits on interest paid. Further housing finance up to Rs. 5 lakh is treated as priority sector advances for banks. The limit has been raised to Rs. 10 lakhs per borrower in cities.6. Educational Loan Scheme:The Reserve Bank of India, from August, 1999 introduced a new Educational Loan Scheme for students of full time graduate/post-graduate professional courses in private professional colleges.Under the scheme all public sector banks have been directed to provide educational loan up to Rs. 15,000 for free seat and Rs. 50,000 for payment seat student at interest not more than 12 per cent per annum. This loan is on clean basis i.e., without calling for security.This loan is available only for students whose annual family income does not exceed Rs. 1, 00,000. The loan has to be repaid together with interest within five years from the date of completion of the course. Studies in respect of the following subjects/areas are covered under the scheme.(a) Medical and dental course.(b) Engineering course.(c) Chemical Technology.(d) Management courses like MBA.(e) Law studies.(f) Computer Science and Applications.This apart, some of the banks have other educational loan schemes against security etc., one can check up the details with the banks.7. Loans against Shares/Securities:Commercial banks provide loans against the security of shares/debentures of reputed companies. Loans are usually given only up to 50% value (Market Value) of the shares subject to a maximum amount permissible as per RBI directives. Presently one can obtain a loan up to Rs.10 lakhs against the physical shares and up to Rs. 20 lakhs against dematerialized shares.8. Loans against Savings Certificates:Banks are also providing loans up to certain value of savings certificates like National Savings Certificate, Fixed Deposit Receipt, Indira Vikas Patra, etc. The loan may be obtained for personal or business purposes.9. Consumer Loans and Advances:One of the important areas for bank financing in recent years is towards purchase of consumer durables like TV sets, Washing Machines, Micro Oven, etc. Banks also provide liberal Car finance.These days banks are competing with one another to lend money for these purposes as default of payment is not high in these areas as the borrowers are usually salaried persons having regular income? Further, bank's interest rate is also higher. Hence, banks improve their profit through such profitable loans.10. Securitization of Loans:Banks are recently trying to securities a part of their part of loan portfolio and sell it to another investor. Under this method, banks will convert their business loans into a security or a document and sell it to some Investment or Fund Manager for cash to enhance their liquidity position.It is a process of transferring credit risk from the banker to the buyer of securitized loans. It involves a cost to the banker but it helps the bank to ensure proper recovery of loan. Accordingly, securitization is the process of changing an illiquid asset into a liquid asset.11. Others:Commercial banks provide other types of advances such as venture capital advances, jewel loans, etc.1. Effective October 18, 1994 banks were free to determine their own prime lending rates (PLRs) for credit limit over Rs. 2 lakh. Data relate to public sector banks.2. The stipulation of minimum maturity period of term deposits was reduced from 30 days to 15 days, effective April 29, 1998. Data relate to public sector banks.3. The change in the Bank Rate was made effective from the close of business of respective dates of change except April 29, 1998.4. Effective April 29, 1998.C. Credit CreationCredit creation is one of the primary functions of commercial banks. When a bank sanctions a loan to the customer, it does not give cash to him. But, a deposit account is opened in his name and the amount is credited to his account. He can withdraw the money whenever he needs.Thus, whenever a bank sanctions a loan it creates a deposit. In this way the bank increases the money supply of the economy. Such functions are known as credit creation.

SECONDARY FUNCTIONSThe secondary functions of the banks consist of agency functions and general utility functions.A. Agency FunctionsAgency functions include the following:(i) Collection of cheques, dividends, and interests:As an agent the bank collects cheques, drafts, promissory notes, interest, dividends etc., on behalf of its customers and credit the amounts to their accounts.Customers may furnish their bank details to corporate where investment is made in shares, debentures, etc. As and when dividend, interest, is due, the companies directly send the warrants/cheques to the bank for credit to customer account.

(ii) Payment of rent, insurance premiums:The bank makes the payments such as rent, insurance premiums, subscriptions, on standing instructions until further notice. Till the order is revoked, the bank will continue to make such payments regularly by debiting the customer's account.(iii) Dealing in foreign exchange:As an agent the commercial banks purchase and sell foreign exchange as well for customers as per RBI Exchange Control Regulations.(iv) Purchase and sale of securities:Commercial banks undertake the purchase and sale of different securities such as shares, debentures, bonds etc., on behalf of their customers. They run a separate 'Portfolio Management Scheme' for their big customers.(v) Act as trustee, executor, attorney, etc:The banks act as executors of Will, trustees and attorneys. It is safe to appoint a bank as a trustee than to appoint an individual. Acting as attorneys of their customers, they receive payments and sign transfer deeds of the properties of their customers.(vi) Act as correspondent:The commercial banks act as a correspondent of their customers. Small banks even get travel tickets, book vehicles; receive letters etc. on behalf of the customers.(vii) Preparations of Income-Tax returns:They prepare income-tax returns and provide advices on tax matters for their customers. For this purpose, they employ tax experts and make their services, available to their customers.B. General Utility ServicesThe General utility services include the following:(i) Safety Locker facility:Safekeeping of important documents, valuables like jewels are one of the oldest services provided by commercial banks. 'Lockers' are small receptacles which are fitted in steel racks and kept inside strong rooms known as vaults. These lockers are available on half-yearly or annual rental basis.The bank merely provides lockers and the key but the valuables are always under the control of its users. Any customer cannot have access to vault.Only customers of safety lockers after entering into a register his name account number and time can enter into the vault. Because the vault is holding important valuables of customers in lockers, it is also known as 'Strong Room'.(ii) Payment Mechanism or Money Transfer:Transfer of funds is one of the important functions performed by commercial banks. Cheques and credit cards are two important payment mechanisms through banks. Despite an increase in financial transactions, banks are managing the transfer of funds process very efficiently.Cheques are also cleared through the banking system. Correspondent banking is another method of transferring funds over long distance, usually from one country to another. Banks, these days employ computers to speed up money transfer and to reduce cost of transferring funds.Electronic Transfer of funds is also known as 'Cheque less banking' where funds are transferred through computers and sophisticated electronic system by using code words. They offer Mail Transfer, Telegraphic Transfer (TT) facility also.(iii) Travellers cheques:Travellers Cheques are used by domestic travellers as well as by international travellers. However the use of travellers cheques is more common by international travellers because of their safety and convenience. These can be also termed as a modified form of travellers letter of credit.A bank issuing travellers cheques usually have banking arrangement with many of the foreign banks abroad, known as correspondent banks. The purchaser of travellers cheques can encase the cheques from all the overseas banks with whom the issuing bank has such an arrangement.Thus travellers cheques are not drawn on specific bank abroad. The cheques are issued in foreign currency and in convenient denominations of ten, twenty, fifty, one hundred dollar, etc. The signature of the buyer/traveler is written on the face of the cheques at the time of their purchase.The cheques also provide blank space for the signature of the traveller to be signed at the time of encashment of each cheque. A traveler has to sign in the blank space at the time of drawing money and in the presence of the paying banker.The paying banker will pay the money only when the signature of the traveler tallies with the signature already available on the cheque.A traveler should never sign the cheque except in the presence of paying banker and only when the traveler desires to encash the cheque. Otherwise it may be misused. The cheques are also accepted by hotels, restaurants, shops, airlines companies for respectable persons.Encashment of a traveler cheque abroad is tantamount to a foreign exchange transaction as it involves conversion of domestic currency into a foreign currency.When a traveller cheque is lost or stolen, the buyer of the cheques has to give a notice to the issuing bank so that stop order can be issued against such lost/stolen cheques to the banks where they are permitted to be encased.It is also difficult to the finder of the cheque to draw cash against it since the encasher has to sign the cheque in the presence of the paying banker. Unused travellers cheques can be surrendered to the issuing bank and balance of cash obtained.The issuing bank levies certain commission depending upon the number and value of travellers cheques issued.

(iv) Circular Notes or Circular Letters of Credit:Under Circular Letters of Credit, the customer/traveller negotiates the drafts with any of the various branches to which they are addressed. Thus the traveller can obtain funds from many of the branches of banks instead only from a particular branch. Circular Letters of Credit are therefore a more useful method for obtaining funds while travelling to many countries.It may be noted that travellers letter of credit are usually paid for in advance. In other words, the traveller first makes payments to the issuing bank before obtaining the Circular Notes.(v) Issue "Travellers Cheques":Banks issue travellers cheques to help carry money safely while travelling within India or abroad. Thus, the customers can travel without fear, theft or loss of money.(vi) Letters of Credit:Letter of Credit is a payment document provided by the buyer's banker in favour of seller. This document guarantees payment to the seller upon production of document mentioned in the Letter of Credit evidencing dispatch of goods to the buyer.The Letter of Credit is an assurance of payment upon fulfilling conditions mentioned in the Letter of Credit. The letter of credit is an important method of payment in international trade. There are primarily 4 parties to a letter of credit.The buyer or importer, the bank which issues the letter of credit, known as opening bank, the person in whose favour the letter of credit is issued or opened (The seller or exporter, known as 'Beneficiary of Letter of Credit'), and the credit receiving/advising bank.The Letter of Credit is generally advised/sent through the seller's bank, known as Negotiating or Advising bank. This is done because the conditions mentioned in the Letter of Credit are, in the first instance; have to be verified by the Negotiating Bank. It is mostly used in international trade.(vii) Acting as Referees:The banks act as referees and supply information about the business transactions and financial standing of their customers on enquiries made by third parties. This is done on the acceptance of the customers and help to increase the business activity in general.(viii) Provides Trade Information:The commercial banks collect information on business and financial conditions etc., and make it available to their customers to help plan their strategy. Trade information service is very useful for those customers going for cross-border business. It will help traders to know the exact business conditions, payment rules and buyers' financial status in other countries.(ix) ATM facilities:The banks today have ATM facilities. Under this system the customers can withdraw their money easily and quickly and 24 hours a day. This is also known as 'Any Time Money'. Customers under this system can withdraw funds i.e., currency notes with a help of certain magnetic card issued by the bank and similarly deposit cash/cheque for credit to account.(x) Credit cards:Banks have introduced credit card system. Credit cards enable a customer to purchase goods and services from certain specified retail and service establishments up to a limit without making immediate payment. In other words, purchases can be made on credit basis on the strength of the credit card.The establishments like Hotels, Shops, Airline Companies, Railways etc., which sell the goods or services on credit forward a monthly or fortnightly statements to the bank.The amount is paid to these establishments by the bank. The bank subsequently collects the dues from the customers by debit to their accounts. Usually, the bank receives certain service charges for every credit card issued. Visa Card, BOB card are some examples of credit cards.(xi) Gift Cheques:The commercial banks offer Gift cheque facilities to the general public. These cheques received a wider acceptance in India. Under this system by paying equivalent amount one can buy gift cheque for presentation on occasions like Wedding, Birthday.(xii) Accepting Bills:On behalf of their customers, the banks accept bills drawn by third parties on its customers. This resembles the letter of credit. While banks accept bills, they provide a better security for payment to seller of goods or drawer of bills.(xiii) Merchant Banking:The commercial banks provide valuable services through their merchant banking divisions or through their subsidiaries to the traders. This is the function of underwriting of securities. They underwrite a portion of the Public issue of shares, Debentures and Bonds of Joint Stock Companies.Such underwriting ensures the expected minimum subscription and also convey to the investing public about the quality of the company issuing the securities. Currently, this type of services can be provided only by separate subsidiaries, known as Merchant Bankers as per SEBI regulations.(xiv) Advice on Financial Matters:The commercial banks also give advice to their customers on financial matters particularly on investment decisions such as expansion, diversification, new ventures, rising of funds etc.(xv) Factoring Service:Today the commercial banks provide factoring service to their customers. It is very much helpful in the development of trade and industry as immediate cash flow and administration of debtors' accounts are taken care of by factors. This service is again provided only by a separate subsidiary as per RBI regulations.Balance sheet is a statement of assets and liabilities on a given date. In India, banks have to publish their balance sheets according to the preformed i.e., 'Form A' given in the III schedule of the Banking Regulation Act, 1949. The study of the balance sheet along with its profit and loss account reveals its financial soundness.A customer has to carefully study these statements to choose his banks. The combined balance sheet of all banks in the country reveals certain economic trends.

Need & Importance of Merchant Banking:

Important reason for the growth of merchant banking has been developmental activity throughout the country, exerting excess demand on the sources of funds for ever expanding industry and trade, thus, leaving a widening gap under bridged between the supply and demand of inventible funds. All Indian financial institutions and experienced resources constraint to meet the ever increasing demands for funds from the corporate sector enterprises. In the circumstances corporate sector had the only alternative to avail of the capital market services for meeting their long-term financial requirements through capital issues of equity and debentures. With the growing demand for funds there was pressure on capital market that enthused the commercial banks, share brokers and financial consultant firms to enter into the field of merchant banking and share the growing capital markets. With the result, all the commercial banks in nationalized and public sector as well as in private sector including the foreign banks in India have opened their merchant banking windows and are competing in this field. There has been a mushroom growth of financial consultancy firms and broker firms doing advisory functions as well as managing public issues in syndication with other merchant bankers.Notwithstanding the above facts, the need of merchant banking institutions is felt in the wake of huge public savings lying still untapped. Merchant banks can play highly significant role in mobilizing funds of savers to investible channels assuring promising return on investments and thus can help in meeting the widening demand for investible funds for economic activity.

With the growth of merchant banking profession corporate enterprises in both public and private sectors would be able to raise required amount of funds annually from the capital market to meet the growing requirements for funds for establishing new enterprises, undertakingExpansion/modernization/diversification of the existing enterprises. This reinforces the need for a vigorous role to be played by merchant banks.

Merchant banks have been procuring impressive support from capital market for the corporate sector for financing their projects. This is evidenced from the increasing amount raised form the capital market by the corporate enterprises year after year. In view of multitude of enactments, rules and regulations, guidelines and offshoot press release instructions brought out by the government from time to time imposing statutory obligations upon the corporate sector to comply with all those requirements prescribed therein, the need of skilled agency existed which could provide counseling in these matters in a package form. Merchant bankers, with their skills, updated information and knowledge, provide this service to the corporate units and advise them on such requirements to be complied with for raising funds from the capital market under different enactments viz. Companies Act, Income-tax Act, Foreign Exchange Regulation Act, Securities Contracts (Regulation) Act and various other corporate laws and regulations. Merchant bankers advise the investors of the incentives available in the form of tax reliefs, other statutory relaxations, good return on investment and capital appreciation in such investment to motivate them to invest their savings in securities of the corporate sector.

Need & Importance of Commercial banking:

Banks have become an essential part of economic life in every field. The development of agriculture and industry are not possible without banks. Modern trade also cannot be thought of without commercial banks.Economic activities in the fields of consumption, production, distribution and other branches of economics cannot be carried on properly without banks. Government also cannot effectively use various monetary and fiscal measures without banks for the accomplishment of various socio-economic objectives.Therefore, the statement of Wicksell seems to be perfectly appropriate when he says that bank is the heart and central point of modern exchange economy. The significance of banks becomes clear looking at the following points.1. Banking and Capital Formation:Capital formation is the basic factor for economic development. Capital formation means creation of physical assets like machines and buildings which increase productive capacity of a country. For capital formation savings are required which are largely mobilised by commercial banks.2. Banking and Investment:The pattern of investment and its quantum that are carried on depend to a large extent on the banking system. An entrepreneur may wish to introduce innovations and this affects economic development positively. Bank credit enables entrepreneurs to innovate and invest, and thus promote economic activity.3. Banking and Industry:Banks are helping industries by providing them credit for establishing new units and updating and expanding the old units.4. Banking and Agriculture:Banks are helping farmers to develop agriculture for providing them long term finance for buying tractors and installing tube-wells.5. Banking and Trade:Banks are helping trade by providing short-term and long-term finance.

The Growth of Merchant Banking in India

In India Merchant Banking activities started from the year 1967, following the footsteps of similar activities in UK & USA. Currently Merchant Banking activity has mushroomed in the Indian capital market with both public & private sector settings up their respective merchant Banking divisions. Currently, the total no. of merchant bankers in India is approx. 1450 with more than 930 registered with SEBI. The SEBI authorized Merchant Bankers Include merchant Banking divisions of All India Financial Institutions, nationalized & foreign banks, subsidies of the commercial banks, private merchant banks engaged in stock broking, underwriting activities & financial consultancy & investment advisory service firms.

Grindlays Banks 1967Citi banks 1970SBI 1973ICICI 1974

Companies raise capital by issuing securities in the market. Merchant bankers act as intermediaries between the issuers of capital and the ultimate investors who purchase these securities.Merchant banking is the financial intermediation that matches the entities that need capital and those that have capital. It is a function that facilitates the flow of capital in the market.

In India a common organizational setup of merchant bankers to operate is in the form of divisions of Indian and foreign banks and financial institutions, subsidiary companies established by bankers like SBI, Canara Bank, Punjab National Bank, Bank of India, etc. Some firms are also organized by financial and technical consultants and professionals. Securities andExchange Board of India has divided the merchant bankers into four categories based on their capital adequacy. Each category is authorized to perform certain functions. From the point of organizational setup Indias merchant banking organizations can be categorized into four groups on the basis of their linkage with parent activity. They are:

(A) Institutional BaseWhere merchant banks function as an independent wing or as subsidiary of various private/Central Governments/State Governments financial institutions. Most of the financial institutions in India are in public sector and therefore such setup plays a role on the lines of government priorities and policies.

(B) Banker Base

These merchant bankers function as division/subsidiary of banking organization. The parent banks are either nationalized commercial bank or the foreign banks operating in India. These organizations have brought professionalism in merchant banking sector and they help their parent organization to make a presence in capital market.

(C) Broker Base

In the recent past there has been an inflow of qualified and professionally skilled brokers in various stock exchanges of India. These brokers undertake merchant banking related operations also like providing investment and portfolio management services.

(D) Private Base

These merchant banking firms are originated in private sector. These organizations are the outcome of opportunities and scope in merchant banking business and they are providing skill-oriented specialized services to their clients. Some foreign merchant bankers are also entering either independently or through some collaboration with their Indian counterparts.Private sector merchant banking firms have come up either as the sole proprietorship or public limited companies. Many of these firms were in existence for quite some times before they added a new activity in the form of merchant banking services by opening new divisions on the lines of commercial banks and All India Financial Institutions.

Merchant Banking in India

Requirements for setting up a merchant banking outfit

Formation of the Business OrganizationSEBI act, 1992 does not prescribe any specific form of business organization to carry on the activities as merchant banker. However, the types of organizations are listed below:a. Sole proprietorshipb. Partnership firmc. Hindu Undivided Family (HUF)d. Corporate Enterprisese. Co-operative Society

Generally it is preferred that the Merchant Banking outfit be a registered company. Merchant Banks are generally setup as subsidiary companies of banks (Public or Private). For example, SBI caps, ICICI Securities etc.

OBJECTIVES OF COMMERCIAL BANKS

A commercial bank has to manage its assets and liabilities with three objectives in mind, namely :- Liquidity, profitability and solvency.Liquidity means the capacity of the bank to give cash on demand in exchange for deposits. But a commercial bank is a profit seeking institution. It has to arrange its assets in such a way that it makes maximum profits. The bank should also maintain the confidence of public by making cash available on demand. Liquidity and profitability are, therefore, conflicting considerations for bankers.Cash has perfect liquidity but yields no return at all, while other income-yielding assets such as loans are profitable but have no liquidity. The bank should strike a balance between liquidity and profitability.Another consideration of the bank is its own solvency and security. This refers to liquidity and shiftability. Liquidity is the capacity to produce cash on demand. Shiftability means the assets acquired by bank should be easily shiftable to other banks or central bank. Those securities would be preferred by a bank which can be shifted easily without any loss to the bank than the risky and more profitable ones. A bank which is solvent may not be liquid. Its assets may exceed its liabilities, but the assets may not be in such a form that they are readily convertible in to cash. Thus, the two motives of a banks liquidity and profitability are contradictory, but have to be reconciled. A good banker is one who follows a wise investment policy and distributes the assets in such a way that both the requirements of liquidity and profitability are satisfied. The assets should bring in maximum profits and should provide maximum security to the depositors. The secret of success of a bank lies in striking a sound balance between liquidity and profitability.

B. RECONCILING TWIN OBJECTIVES :-

A good banker is one who follows a wise investment policy and distributes the assets in such a way that both the requirements of liquidity and profitability are satisfied. The secret of success of a bank lies in striking a balance between liquidity and profitability. The commercial bank arranges its assets in an ascending order of profitability and descending order of liquidity. As we move down the balance sheet the assets become less and less liquid and more and more profitable. The more liquid the assets, the less profitable it is. Let us Explain :-

1) Cash :- Cash balance have perfect liquidity, but no profitability. Cash is held to meet the withdrawl needs of depositors.

2) Money At Call :-Surplus cash of commercial banks is lend to each other. This earns some interest and is also very liquid.

3) Investment In Securities :-

Statutorily banks have to invest a part of their assets in government securities. These securities have low rate of interest but banks can borrow from RBI against these securities. Thus investment in securities provide returns as well as liquidity to bank.

4) Loans And Advances :-

Here liquidity is low but profitability is high.

Thus banks hold various assets in such a way that the requirements of liquidity and profitability are balanced.

OBJECTIVES OF MERCHANT BANKS1.To act as a Merchant Bankers, Portfolio Managers, Underwriters, Sub-Underwriters, Consultants for Capital Issues, Advisors to Capital Issues, Registrars to the issue, Share Transfer Agents, Investment Consultants, Consultants and Management Advisors to Corporate Bodies, Individuals and Promoters in commercial, industrial management and policy matters and to make project evaluation, feasibility studies, project report, and surveys and to give expert advice and suggest ways and means for improving efficiency in business organization and concerns and industries of all kinds and/or to act as lead managers, co-managers to issue of shares, stocks, bonds, debentures, commercial paper or other securities of bodies corporate or industrial undertaking and/or shares ,stocks, bonds, debentures, commercial paper or other securities issued to any government or semi-government authority or public authority of government under taking or stocks, bonds, debentures or of the securities.2. To carry on business of investment and to undertake and transact and deal in bills of exchange, hundies, promissory notes and other negotiable instruments and securities and also to issue on commission, to subscribe for, underwrite, take, acquire and hold, sell and exchange and deal in shares, stocks, bonds or debentures or securities of any government or public authority and/or to acquire any such shares, stocks, debentures, bonds by original subscriptions, exchange or otherwise and to subscribe for the same either conditionally or otherwise and to guarantee the subscription thereof. Merchant banker registered with SEBI:

Public Sector: - Commercial banks (24), Financial Institutions (6), State Institutions (4)Private sector: - International bankers (10), Banks (10), finance & investment (231).

The following comprise the main functions of a merchant banker in India:

1. Management of debt and equity offerings.2. Placement and distribution.3. Issue Management.4. Underwriting of Public Issue.5. Project Counseling.6. Institutions and obtaining government approval.7. Providing venture capital and mezzanine financing.8. Portfolio Management.9. Off Shore Finance.10. Corporate Counseling and advisory services.11. Non-resident Investment.12. Loan Syndication.13. Placement and distribution.14. Working Capital Finance.15. Venture Capital.16. Lease Financing.17. Fixed Deposit Broking.18. Mutual Funds.19. Accepting Credit & Discounting of Bills.20. Relief to sick Industries.21. Project Appraisal.22. Financial Appraisal.23. Technical Appraisal.24. Economical Appraisal.

1. Management of debt and equity offerings- This forms the main function of the merchant banker. He assists the companies in raising funds from the market. The main areas of work in this regard include: instrument designing, pricing the issue, registration of the offer document, underwriting support, and marketing of the issue, allotment and refund, listing on stock exchanges. 2. Placement and distribution- The merchant banker helps in distributing various securities like equity shares, debt instruments, mutual fund products, fixed deposits, insurance products, commercial paper to name a few. The distribution network of the merchant banker can be classified as institutional and retail in nature. The institutional network consists of mutual funds, foreign institutional investors, private equity funds, pension funds, financial institutions etc. The size of such a network represents the wholesale reach of the merchant banker. The retail network depends on networking with investors.

3. Issue Management:Management of issue involves marketing of corporate securities viz. equity shares, preference shares and debentures or bonds by offering them to public. Merchant banks act as an intermediary whose main job is to transfer capital from those who own it to those who need it. After taking action as per SEBI guidelines, the merchant banker arranges a meeting with company representatives and advertising agents to finalize.Arrangements relating to date of opening and closing of issue, registration of prospectus, launching publicity campaign and fixing date of board meeting to approve and sign prospectus and pass the necessary resolutions. Pricing of issues is done by the companies in consultant with the merchant bankers.

4. Underwriting of Public Issue: Underwriting is a guarantee given by the underwriter that in the event of under subscription, the amount underwritten would be subscribed by him. Banks/Merchant banking subsidiaries cannot underwrite more than 15% of any issue.

Financial structuring includes determining the right debt-equity ratio and gearing ratio for the client; the appropriate capital structure theory is also framed. Merchant bankers also explore the refinancing alternatives of the client, and evaluate cheaper sources of funds. Another area of advice is rehabilitation and turnaround management. In case of sick units, merchant bankers may design a revival package in coordination with banks and financial institutions. Risk management is another area where advice from a merchant banker is sought. He advises the client on different hedging strategies and suggests the appropriate strategy.

5. Project Counseling: Project counseling includes preparation of project reports, deciding upon the financing pattern to finance the cost of the project and appraising the project report with the financial institutions or banks. It also includes filling up of application forms with relevant information for obtaining funds from financial.

6. Institutions and obtaining government approval:Loan syndication- Merchant bankers arrange to tie up loans for their clients. This takes place in a series of steps. Firstly they analyses the pattern of the clients cash flows, based on which the terms of borrowings can be defined. Then the merchant banker prepares a detailed loan memorandum, which is circulated to various banks and financial institutions and they are invited to participate in the syndicate.

7. Providing venture capital and mezzanine financing- Merchant bankers help companies in obtaining venture capital financing for financing their new and innovative strategies.

8. Portfolio Management: Portfolio refers to investment in different kinds of securities such as shares, debentures or bonds issued by different companies and government securities. Portfolio management refers to maintaining proper combinations of securities in a manner that they give maximum return with minimum risk.

9. Off Shore Finance:The merchant bankers help their clients in the following areas involving foreign currency.(a) Long term foreign currency loans(b) Joint Ventures abroad(c) Financing exports and imports(d) Foreign collaboration arrangementsNon-resident Investment: The services of merchant banker includes investment advisory services to NRI in terms of identification of investment opportunities, selection of securities, investment management, and operational services like purchase and sale of securities.10. Corporate Counseling and advisory services: Corporate counseling covers the entire field of merchant banking activities viz. project counseling, capital restructuring, public issue management, loan syndication, working capital, fixed deposit, lease financing acceptance credit, etc. Merchant bankers also offer customized solutions to their clients financial problems.

11. Corporate Counseling and advisory services:

The services of merchant banker includes investment advisory services to NRI in terms of classification of investment opportunities, selection of securities, investment management, and operational services like purchase and sale of securities.

12. Loan Syndication

Loan syndication is an assistance provided by merchant bankers to get mainly term loans for projects. Such loans may be obtained from a single development finance institution or a syndicate or consortium. Merchant bankers help corporate clients to raise syndicated loans from banks and other financial institutions.

13. Placement and distributionThe merchant banker helps in distributing different securities like equity shares, debt instruments, mutual fund products, fixed deposits, insurance products, commercial paper, etc. The distribution network of the merchant banker can be classified as institutional and retail in character. The institutional network consists of mutual funds, foreign institutional investors, private equity funds, pension funds, financial institutions etc. The size of such a network signifies the wholesale reach of the merchant banker. The retail network is purely depends on networking with investors.

14. Working Capital Finance

The finance required for day to day expenses of enterprises is known as Working Capital Financea) Assessment of working capital requirement.b) Preparing the necessary application to negotiation for the sanction of appropriate credit facilities.c) Co-ordinating, Assisting

15. Venture Capital

Leasing is important alternative source of financing a capital outlay. The concept of venture capital originated in U.S.A in 1950s.

16. Lease Financing

In India, lease financing is non-banking activity. Commercial Banks like State Bank of India & Canara Bank also provided lease financing by forming subsidiary under the amended Banking Regulation Act 1949.

17. Fixed Deposit Broking

Following are the services rendered by the merchant bankersa) Computation of amount that could be raised in the form of deposits from the public and loans for shareholders.b) Drafting of advertising for invitation of deposits.c) Filing of a copy of advertisement with Registrar of Companies.d) Helping the company by observing whether the rules & regulations are followed.

18. Mutual Funds

Mutual funds are institutions of mobilizing of saving of investors towards productive investments in wide variety of corporate & other securities.

Following are some services rendered by mutual fundsa) Mopping up public savings.b) Investing the fund in diversified portfolio of shares & debentures belonging well managed & growing companies.

Fundamentally, merchant banking division is regarded as a project-evaluation instrument.

It provides expert knowledge and help in the floatation of new companies, the preparation, planning and execution of new projects, and the management and promotion of industrial enterprises as well as their financing. Basically, however, merchant banks are more service-oriented.

Their main function is to guide the preparation, planning, evaluation and execution of projects which are helpful to the growth of industries.

In specific terms, however, the main function assumed by the merchant banking division of the National & Grindlays Bank are as under:

(i) To give advice and assistance to entrepreneurs in planning their finances.

(ii) To match the needs of the customer for all types of finance with available resources for such finances, national or international.

(iii) To act as an intermediary and expert for advising and assisting in raising share capital or loan capital.

(iv) To assist customers in long-range planning for growth and effectiveness.

(u) To promote international investment.

(vi) To provide specialized services and assistance to small and medium-sized industries, as well as to the joint sector industries.

Similarly, the following functions have been specified for the merchant banking division of State Bank of India.

(a) To furnish advice, assist and liaison in meeting with allied government formalities, required in establishing or expanding industrial projects.

(b) To prepare economic, technical and financial feasibility reports and survey reports for setting up new industrial projects.

(c) To render assistance in raising rupee loans from term lending institutions, development banks, commercial banks and such other institutions.

(d) To give assistance in raising foreign exchange resources.

(e) To provide assistance and advice in determining the capital structure, in obtaining official consent and in handling and floating capital issues and such other activities as are engaged in by the registrars or issues houses.

(f) To advise and assist in restructuring of capital, amalgamation, mergers, etc.

(g) To advise and assist in adopting the best form of industrial organisation.

(h) To help in financing foreign trade.

In general, however, the merchant banking activities of the Indian banks have been largely confined to the management of public issues and loan syndications.

They have yet to develop expertise in the fields of projects counseling, corporate counseling, capital restructuring, portfolio management, etc.22. Financial Appraisal

Financial Appraisal involves assessing the feasibility of new proposal for setting up new project for the expansion of the existing production facilities.

Financial Appraisal is undertaken through an analysis which takes in to account the financial feature of the product, including source of financing. It helps in tracing of smooth operation of the project over its entire life cycle.

23. Technical Appraisal

Technical Appraisal is the primary concern with the project concept in terms of it technology, design, scope & content of plant, as well as the input are infrastructure facilities envisage the project. Basically, the project should be able to deliver a marketable product for the resources deployed.

24. Economic Appraisal Economic Appraisal of a project deals with the impact of project on economics aggregates.Merchant bankers render their specialized assistance in achieving the main objectives which are presented below:To carry on the business of merchant banking, assist in the capital formation, manage advice, underwrite, provide standby assistance, securities and all kinds of investments issued, to be issued or guaranteed by any company, corporation, society, firm, trust person, government, municipality, civil body, public authority established in India.

The main object of merchant banker is to create secondary market for bills and discount or re-discount bills and acts as an acceptance house.

Merchant bankers another objective is to set up and provide services for the venture capital technology funds.

They also provide services to the finance housing schemes for the construction of houses and buying of land.

They render the services like foreign exchange dealer, money exchange, and authorized dealer and to buy and sell foreign exchange in all lawful ways in compliance with the relevant laws of India.

They will invest in buying and selling of transfers, hypothecate and deal with dispose of shares, stocks, debentures, securities and properties of any other company.

Obligations and Responsibilities Of merchant bank

Merchant bankers have the following obligations and responsibilities. Merchant banker should maintain proper books of accounts, records and submit half yearly/annual financial statements to the SEBI within stipulated period of time. No merchant banker should associate with another merchant banker who is not registered in SEBI. Merchant bankers should not enter into any transactions on the basis of unpublished information available to them in the course of their professional assignment. Every merchant banker must submit himself to the inspection by SEBI when required for and submit all the records. Every merchant banker must disclose information to the SEBI when it requires any information from them.

All merchant bankers must abide by the code of conduct prescribed for them.Every merchant banker who acts as lead manager must enter into an agreement with the issuer setting out mutual rights, liabilities, obligations, relating to such issues with particular reference to disclosures allotment, refund etc.

Obligations and Responsibilities of commercial bank

The commercial BanksThe commercial bank is an organized financial institution that deals with the business of credit (borrowing and lending of money). The commercial banks are financial intermediaries between savers and investors. Like other business firms, the main objective of commercial banks is to earn profits. The bank accepts deposits from its customers and thus raises large funds that can be loaned out. These may be in the form of demand deposit (readily available for checking: often called current accounts on which the banks pay no interest), or time deposits (which can be available only for business/loan extension). The saving deposits fall in between the two, which can be withdrawn occasionally. The deposits accepted by a bank are its liability and the loan extended to the clients as well as the bonds/shares of firms held by the bank constitute its assets. The bank earns interest/profit on its investment a part of which is passed on to the depositors and the remaining is appropriated. The Process of Credit CreationThe commercial banks provide an easy medium of exchange in the form of checks, drafts, credit cards etc. These are called bank notes or instruments of credit. These constitute a considerable part of the total money supply in the economy. Anyhow, the banks cannot create money from thin air; they convert physical wealth into liquid money. There must be an initial deposit with the bank to start the process. Further, the power of the banks to create credit is limited by the reserve requirements.Developments in Merchant banking Establishments in India

Setting up of banks Subsidiaries:

In order to meet the growing demand for broad-based financial services from the corporate sector more effectively, the merchant banking division of the nationalize banks have stated forming independent subsidiaries. These subsidiaries offer more specialized services with professional, expertise & skills. SBI capital market ltd. was incorporated as the first such subsidiary of SBI on 2 July, 1986. Then CAN BANK financial services ltd was set up as wholly owned subsidiary of Canara bank in 1987. PNB Capital Market was promoted by PNB during Mid-1988. Many more subsidiaries are being set up by another nationalize banks.

Reorganization of private Firms:

Expecting tough Competition from growing number of merchant banking subsidiary of nationalized banks, private merchant bankers have also started reorganizing their activities e.g., J.M Financial & Investment Consultancy Ltd., 20th century finance corporation ltd., LKP merchant financing ltd are some of the private sector firms of merchant bankers who have taken steps to reorganize their activities.

Establishment of SUA:

In order to educate and protect the interest of investor, to provide information about new issues of capital market, to evolve a code of conduct for underwriters & to render legal & other services to members & public, the STOCKBROKER UNDERWRITER ASSOCIATION (SUA) was established in 1984.

Discount & Finance House of India (DFHI)

DFHI was incorporated as a company under the company act 1956 with an authorized & paid up capital of Rs 100 crores. Out of this Rs 51 crores has been contributed by RBI, Rs 16 crores but financial institutions & 33 crores by public sector banks. It would also have line of credit from public sector banks; refinance facility from the RBI in order to meet the working capital requirement. DFHI aims at providing liquidity in money market as it deals mainly in commercial bills.

Credit Rating Information Services of India Ltd. (CRISIL)

CRISIL has been set up in 1987 to provide help to investors, merchant bankers, underwriters, brokers, banks & financial institutions etc. CRISIL rates various types of instruments such as debt, Equity, & Fixed return security offered to the public. It helps the investor in taking investment decisions.

Stock-Holding Corporation of India Ltd. (SHC)

SHC was set up in 1986 by the all Indian financial institutions to take care of safe custody, delivery of shares & collection of sale proceeds of the securities. The setting up of SHC is bound to affect the capital market aim future.

Development of commercial bank in India

The Second World War had a tremendous impact on the Indian banking system. Therewas a phenomenal growth of banking, in terms of resources as well as number of offices,under the stimulus of monetary expansion and the large-scale war effort. The Indianbanking system as a whole withstood the strains of the war period very well and displayedremarkable resilience and vigour in several directions. There is no doubt that therewas also growth of the banking habit in the country. However, the war-time bankingstructure presented several disquieting features too, which were particularly marked inthe case of the newly established units. While the needs of the economy during the warwarranted a rapid expansion of banking and there was certainly room for some newinstitutions, there was a pronounced tendency for opening banks with little intrinsicstrength in the form of a sound capital structure and liquidity of assets; more serious wasthe rather indiscriminate opening of branches and the employment of unsound methods to attract deposits. The motives behind several of the new banking ventures were notaltogether legitimate or worthy. There was evidently a desire to get control over publicfunds for speculative investments and trading activities and also for pecuniary gains inmany ways through excessive salaries, bonus, commission, etc. There was again, in somecases, a desire on the part of industrial houses to have under their control sizeablebanking and insurance establishments; this interlocking of interests between banks,insurance companies and industrial concerns was generally detrimental to the interests ofbank depositors. There was moreover, in some cases, the dressing up of accounts to givea misleading impression of the financial position of the bank. A number of banks also engaged in dubious devices to become eligible for inclusion in the Second Schedule.

These developments lent urgency to the passing of comprehensive bankinglegislation. Unfortunately, this did not materialise during the war period. In the earlyyears of the war, the Bank itself desired postponement of such legislation; in the later waryears, the new Governor made every possible effort to get the measure enacted but thisdid not prove possible owing to circumstances beyond the Banks control. However,some ad hoc enactments were made to deal with some specific abuses and shortcomingsof the banking system. The Reserve Bank spared no pains to have an adequate statutorybase for the regulation of the banks on sound yet progressive lines. The Banks contactswith the commercial banks, both scheduled and non-scheduled, became much closerduring the war; these would in any case have taken place, but the war developments madeit all the more imperative on the part of the Bank to be in a position to keep a close watch on the banking system.

Recent Banking Developments in India

The Indian banking sector has witnessed wide ranging changes under the influence of the financial sector reforms initiated during the early 1990s. The approach to such reforms in India has been one of gradual and non-disruptive progress through a consultative process. The emphasis has been on deregulation and opening up the banking sector to market forces. The Reserve Bank has been consistently working towards the establishment of an enabling regulatory framework with prompt and effective supervision as well as the development of technological and institutional infrastructure.

Persistent efforts have been made towards adoption of international benchmarks as appropriate to Indian conditions. While certain changes in the legal infrastructure are yet to be effected, the developments so far have brought the Indian financial system closer to global standards.

Statutory Pre-emption

In the pre-reforms phase, the Indian banking system operated with a high level of statutory preemptions, in the form of both the Cash Reserve Ratio (CRR) and the Statutory Liquidity Ratio (SLR), reflecting the high level of the countrys fiscal deficit and its high degree of monetisation. Efforts in the recent period have been focused on lowering both the CRR and SLR. The statutory minimum of 25 per cent for the SLR was reached as early as 1997, and while the Reserve Bank continues to pursue its medium-term objective of reducing the CRR to the statutory minimum level of 3.0 per cent, the CRR of the Scheduled Commercial Banks (SCBs) is currently placed at 5.0 per cent of NDTL (net demand and time liabilities). The legislative changes proposed by the Government in the Union Budget, 2005-06 to remove the limits on the SLR and CRR are expected to provide freedom to the Reserve Bank in the conduct of monetary policy and also lend further flexibility to the banking system in the deployment of resources.

Interest Rate Structure

Deregulation of interest rates has been one of the key features of financial sector reforms. In recent years, it has improved the competitiveness of the financial environment and strengthened the transmission mechanism of monetary policy. Sequencing of interest rate deregulation has also enabled better price discovery and imparted greater efficiency to the resource allocation process. The process has been gradual and predicated upon the institution of prudential regulation of the banking system, market behavior, financial opening and, above all, the underlying macroeconomic conditions.

Interest rates have now been largely deregulated except in the case of: (i) savings deposit accounts;(ii) non-resident Indian (NRI) deposits; (iii) small loans up to Rs.2 lakh; and (iv) export credit. After the interest rate deregulation, banks became free to determine their own lending interest rates.As advised by the Indian Banks Association (a self-regulatory organisation for banks), commercial banks determine their respective BPLRs (benchmark prime lending rates) taking into consideration:

(i) actual cost of funds; (ii) operating expenses; and (iii) a minimum margin to cover regulatory requirements of provisioning and capital charge and profit margin. These factors differ from bank to bank and feed into the determination of BPLR and spreads of banks. The BPLRs of public sector banks declined to 10.25-11.25 per cent in March 2005 from 10.25-11.50 per cent in March 2004. With a view to granting operational autonomy to public sector banks, public ownership in these banks was reduced by allowing them to raise capital from the equity market of up to 49 per cent of paid-up capital. Competition is being fostered by permitting new private sector banks, and more liberal entry of branches of foreign banks, joint-venture banks and insurance companies. Recently, a roadmap for the presence of foreign banks in India was released which sets out the process of the gradual opening-upof the banking sector in a transparent manner. Foreign investments in the financial sector in the form of Foreign Direct Investment (FDI) as well as portfolio investment have been permitted. Furthermore, banks have been allowed to diversify product portfolio and business activities. The share of public sector banks in the banking business is going down, particularly in metropolitan areas. Some diversification of ownership in select public sector banks has helped further the move towards autonomy and thus provided some response to competitive pressures. Transparency and disclosure standards have been enhanced to meet international standards in an ongoing manner.

Prudential Regulation

Prudential norms related to risk-weighted capital adequacy requirements, accounting, incomerecognition, provisioning and exposure were introduced in 1992 and gradually these norms have been brought up to international standards. Other initiatives in the area of strengthening prudential norms include measures to strengthen risk management through recognition of different components of risk,assignment of risk-weights to various asset classes, norms on connected lending and risk concentration, application of the mark-to-market principle for investment portfolios and limits on deployment of funds in sensitive activities.Keeping in view the Reserve Banks goal to achieve consistency and harmony with international standards and our approach to adopt these standards at a pace appropriate to our context, it has been decided to migrate to Basel II. Banks are required to maintain a minimum CRAR (capital to risk weighted assets ratio) of 9 per cent on an ongoing basis. The capital requirements are uniformly applied to all banks, including foreign banks operating in India, by way of prudential guidelines on capital adequacy. Commercial banks in India will start implementing Basel II with effect from March 31,2007. They will initially adopt the Standardised Approach for credit risk and the Basic Indicator Approach for operational risk. After adequate skills have been developed, at both bank and supervisory level, some banks may be allowed to migrate to the Internal Ratings-Based (IRB) Approach. Banks have also been advised to formulate and operationalise the Capital Adequacy Assessment Process (CAAP) as required under Pillar II of the New Framework.Some of the other regulatory initiatives relevant to Basel II that have been implemented by the Reserve Bank are:

Ensuring that banks have a suitable risk management framework oriented towards theirrequirements and dictated by the size and complexity of their business, risk philosophy,market perceptions and expected level of capital.

Introducing Risk-Based Supervision (RBS) in select banks on a pilot basis.

Encouraging banks to formalise their CAAP in alignment with their business plan andperformance budgeting system. This, together with the adoption of RBS, should aid in fulfilling the Pillar II requirements under Basel II.

Expanding the area of disclosures (Pillar III) so as to achieve greater transparency regarding the financial position and risk profile of banks.

Building capacity to ensure the regulators ability to identify eligible banks and permit them toadopt IRB/Advanced Measurement approaches.

With a view to ensuring migration to Basel II in a non-disruptive manner, a consultative andparticipative approach has been adopted for both designing and implementing the New Framework. A Steering Committee comprising senior officials from 14 banks (public, private and foreign) with representation from the Indian Banks Association and the Reserve Bank has been constituted. On the basis of recommendations of the Steering Committee, draft guidelines on implementation of the New Capital Adequacy Framework have been issued to banks.

In order to assess the impact of Basel II adoption in various jurisdictions and re-calibrate theproposals, the BCBS is currently undertaking the Fifth Quantitative Impact Study (QIS 5). India will be participating in the study, and has selected 11 banks which form a representative sample for this purpose. These banks account for 51.20 per cent of market share in terms of assets. They have been advised to familiarise themselves with the QIS 5 requirements to enable them to participate in the exercise effectively. The Reserve Bank is currently focusing on the issue of recognition of the external rating agencies for use in the Standardised Approach for credit risk.

As a well-established risk management system is a pre-requisite for implementation of advanced approaches under the New Capital Adequacy Framework, banks were required to examine the various options available under the Framework and draw up a roadmap for migration to Basel II. The feedback received from banks suggests that a few may be keen on implementing the advanced approaches.

However, not all are fully equipped to do so straightaway and are, therefore, looking to migrate to the advanced approaches at a later date. Basel II provides that banks should be allowed to adopt/migrate to advanced approaches only with the specific approval of the supervisor, after ensuring that they satisfy the minimum requirements specified in the Framework, not only at the time of adoption/migration, but on a continuing basis. Hence, banks desirous of adopting the advanced approaches must perform a stringent assessment of their compliance with the minimum requirements before they shift gears to migrate to these approaches. In this context, current non-availability of acceptable and qualitative historical data relevant to internal credit risk ratings and operational risk losses, along with the related costs involved in building up and maintaining the requisite database, is expected to influence the pace of migration to the advanced approaches available under Basel II.

Exposure Norms

The Reserve Bank has prescribed regulatory limits on banks exposure to individual and group borrowers to avoid concentration of credit, and has advised banks to fix limits on their exposure to specific industries or sectors (real estate) to ensure better risk management. In addition, banks are also required to observe certain statutory and regulatory limits in respect of their exposures to capital markets.

Asset-Liability Management

In view of the growing need for banks to be able to identify, measure, monitor and control risks, appropriate risk management guidelines have been issued from time to time by the Reserve Bank, including guidelines on Asset-Liability Management (ALM). These guidelines are intended to serve as a benchmark for banks to establish an integrated risk management system. However, banks can also develop their own systems compatible with type and size of operations as well as risk perception and put in place a proper system for covering the existing deficiencies and the requisite upgrading.

Detailed guidelines on the management of credit risk, market risk, operational risk, etc. have also beenissued to banks by the Reserve Bank. The progress made by the banks is monitored on a quarterly basis. With regard to risk management techniques, banks are at different stages of drawing up a comprehensive credit rating system, undertaking a credit risk assessment on a half yearly basis, pricing loans on the basis of risk rating, adopting the Risk-Adjusted Return on Capital (RAROC) framework of pricing, etc. Some banks stipulate a quantitative ceiling on aggregate exposures in specified risk categories, analyse rating-wisedistribution of borrowers in various industries, etc.

In respect of market risk, almost all banks have an Asset-Liability Management Committee. They have articulated market risk management policies and procedures, and have undertaken studies of behavioural maturity patterns of various components of on-/off-balance sheet items.

NPL Management

Banks have been provided with a menu of options for disposal/recovery of NPLs (non-performing loans). Banks resolve/recover their NPLs through compromise/one time settlement, filing of suits, Debt Recovery Tribunals, the Lok Adalat (peoples court) forum, Corporate Debt Restructuring (CDR), sale to securitisation/reconstruction companies and other banks or to non-banking finance companies (NBFCs). The promulgation of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 and its subsequent amendment have strengthened the position of creditors. Another significant measure has been the setting-up of the 240 BIS Papers No 28Credit Information Bureau for information sharing on defaulters and other borrowers. The role of Credit Information Bureau of India Ltd. (CIBIL) in improving the quality of credit analysis by financial institutions and banks need hardly be overemphasised. With the enactment of the Credit Information Companies (Regulation) Act, 2005, the legal framework has been put in place to facilitate the fullfledged operationalisation of CIBIL and the introduction of other credit bureaus.

Board for Financial Supervision (BFS)

An independent Board for Financial Supervision (BFS) under the aegis of the Reserve Bank has been established as the apex supervisory authority for commercial banks, financial institutions, urban banks and NBFCs. Consistent with international practice, the Boards focus is on offsite and on-site inspections and on banks internal control systems. Offsite surveillance has been strengthened through control returns. The role of statutory auditors has been emphasised with increased internal control through strengthening of the internal audit function. Significant progress has been made in implementation of the Core Principles for Effective Banking Supervision. The supervisory rating system under CAMELS has been established, coupled with a move towards risk-based supervision.

Consolidated supervision of financial conglomerates has since been introduced with bi-annual discussions with the financial conglomerates. There have also been initiatives aimed at strengthening corporate governance through enhanced due diligence on important shareholders, and fit and proper tests for directors.A scheme of Prompt Corrective Action (PCA) is in place for attending to banks showing steady deterioration in financial health. Three financial indicators, viz. capital to risk-weighted assets ratio (CRAR), net non-performing assets (net NPA) and Return on Assets (RoA) have been identified with specific threshold limits. When the indicators fall below the threshold level (CRAR, RoA) or go above it (net NPAs), the PCA scheme envisages certain structured/discretionary actions to be taken by the regulator.The structured actions in the case of CRAR falling below the trigger point may include, among other things, submission and implementation of a capital restoration plan, restriction on expansion of risk weighted assets, restriction on entering into new lines of business, reducing/skipping dividend payments, and requirement for recapitalisation.The structured actions in the case of RoA falling below the trigger level may include, among other things, restriction on accessing/renewing costly deposits and CDs, a requirement to take steps to increase fee-based income and to contain administrative expenses, not to enter new lines of business, imposition of restrictions on borrowings from the inter bank market, etc.In the case of increasing net NPAs, structured actions will include, among other things, undertaking a special drive to reduce the stock of NPAs and containing the generation of fresh NPAs, reviewing the loan policy of the bank, taking steps to upgrade credit appraisal skills and systems and to strengthen follow-up of advances, including a loan review mechanism for large loans, following up suitfiled decreed debts effectively, putting in place proper credit risk management policies/processes/procedures/prudential limits, reducing loan concentration, etc. Discretionary action may include restrictions on capital expenditure, expansion in staff, and increase of stake in subsidiaries. The Reserve Bank/Government may take steps to change promoters/ ownership and may even take steps to merge/amalgamate/liquidate the bank or impose a moratorium on it if itsposition does not improve within an agreed period.

Technological Infrastructure

In recent years, the Reserve Bank has endeavoured to improve the efficiency of the financial system by ensuring the presence of a safe, secure and effective payment and settlement system. In the process, apart from performing regulatory and oversight functions the Reserve Bank has also played an important role in promoting the systems functionality and modernisation on an ongoing basis. The consolidation of the existing payment systems revolves around strengthening computerised cheque clearing, and expanding the reach of Electronic Clearing Services (ECS) and Electronic Funds BIS Papers No 28 241Transfer (EFT). The critical elements of the developmental strategy are the opening of new clearing houses, interconnection of clearing houses through the